Capital Gains Tax in a 1031 Exchange

When there is a sale, the IRS sees this as a taxable event. With the sale of real estate, a seller will find themselves responsible for capital gains tax (Topic 409 - Capital Gains and Losses), a tax on the profit from the sale of a property or investment. For many sellers, this turns out to be a significant amount which they were hoping to reinvest with.

At 1031 Exchange Connection, we speak to clients all day who are looking to sell their property, but dread the idea of paying capital gains taxes. As 1031 Exchange consultants and Qualified Intermediaries, we help our clients successfully utilize the 1031 exchange strategy to defer their capital gains tax and reinvest their equity back into a new investment property, saving our clients from having to write a check to Uncle Sam.

The most common question we get regarding this topic is "what amount of capital gains tax will I pay on my sale?" Most just need a general idea of the amount of tax, or the rate (percentage) of capital gains tax on their sale, in order to decide how to move forward, i.e. should I do the 1031 exchange, or just pay the tax?

Determining the exact amount of the tax is not that easy, as it largely depends on how you are holding title. For example, if you are holding title to your property as an individual and held it long term, i.e. greater than 1 year, you can bet on 15%. However, if you are in a higher tax bracket, 15% turns to 20%, and in many cases the Affordable Care Act, aka Obamacare, kicks in an additional 3.8%. Still there's more, such as 25% depreciation recapture if you've taken depreciation deductions over the years on your property. Don't forget about the 0.9% Net Investment Income Tax. And, what if you live in a taxable state, like New York or New Jersey, where the state income tax rates hover around 10% on top of the federal tax. It's daunting, yes? This is why it's so important to speak with your CPA or tax preparer to get a better picture of the tax bill on your sale.

Before doing the 1031 exchange, we always advise that you speak to your CPA to determine if a 1031 exchange will be beneficial when selling your investment property. Then, give us a call. We'd be happy to take it from there and discuss your situation with you, explain the process, answer any questions you may have, and help you successfully utilize a 1031 exchange!